HELOCs and Home Equity Loans

HELOC and home equity loan and adjustable rate mortgage and debt-to-income are terms you might have heard when navigating the real estate sector, but these concepts are not that complex if you talk to the right professional and do your homework before applying for a property-backed loan. To make sure your HELOC or home equity loan is approved, you should have the proper documentation ready and use online comparison tools to figure out the best yet cheapest lender – in terms of interest rate charged, closing fees and administrative fees.

What Is a HELOC?

In a home equity line of credit, or HELOC, a lender agrees to advance funds to you, the borrower, up to your equity in a property that serves as collateral. The HELOC typically is valid for a specific term, such as 6 months, one year or 36 months.

The HELOC bears some similarities with a second mortgage loan because the HELOC lender's claim generally comes after the primary lender's claims have been satisfied. HELOC lenders try not to advance a loan amount that is close to the collateral amount, so they leave some financial legroom within which they can maneuver and avert losses. For example, your house is worth $500,000, and you currently have an outstanding mortgage of $350,000. As a result, your equity in the house equals $150,000, or $500,000 minus $350,000. Because of your stellar credit score and financial situation, a lender could agree to grant you a 50% HELOC, meaning the creditor would lend you half of your equity amount, or $75,000. The interest rate is typically variable on a HELOC.

How Does a HELOC Work?

A HELOC works the same way the plastic in your wallet operates. Similar to a credit card, a HELOC agreement mandates that you not exceed your credit limit and make the minimum payment at the end of each month. The lender advances you the fund, and you can tap into the money as much as you want, as long as you abide by the HELOC terms and conditions. You don't have to repay the full balance each month, but interest continues to accrue on open balances. The bank continuously checks your credit file to make sure you are current with other lenders and that you are not falling by the wayside, financially speaking. As long as you repay the amount used, the credit line replenishes itself and you can use the funds again and again and again.

Where Can I Get a HELOC?

Contact your bank to see whether there are HELOC opportunities available to someone in your situation. I don't think it is a good idea to reach out to the lending institution who granted you the mortgage loan initially because the company might not want to "double down" on you, no matter the perfection of your credit score. In other words, the lender might not grant your HELOC application for fear the losses would be too much if you were to default or face financial tumult. To sum it up: the bank would not want to put all their eggs in the same basket – your basket.

What Are HELOC Requirements?

HELOC requirements vary by bank and state, but some features are common to most, if not all, of them.

Timely Mortgage Payment - You must not be behind in your current mortgage payments. The prospective HELOC lender would not want you to use the new loan proceeds to repay the first mortgage.

Home Equity – You must possess equity in your home before applying for a HELOC. Put differently, you cannot apply for such a loan if your outstanding mortgage amount exceeds the house's market value, a scenario that causes a loss for you.

Credit Rating – It might be difficult to land a HELOC is your credit score is in subprime category – that is, hovers below 640.

Debt-to-Income Ratio – This metric tells the prospective HELOC lender whether you can afford taking on a new loan and monthly payments. Debt-to-income ratio equals your total debt payments divided by your income, everything being on a monthly basis. A ratio of 30% or 40% is preferable, but it is not unusual to see a bank approving the HELOC application of someone who has a high debt-to-income metric.

Income - Lenders would want you to verify your employment history as well as to confirm that you are currently working and have been employed for the last two to three years. The goal here is to make sure you have enough financial flexibility to take on additional debt.

Documentation – The HELOC underwriter may require specific paperwork to confirm things like income, income tax returns and homeowners insurance.

What Is a Home Equity Loan?

A home equity loan takes the equity in your house as collateral, but unlike a HELOC, has a fixed term and specific payment amounts and dates. Think of it as a traditional loan, except that it is backed by the equity in your principal residence. In other words, if you do not pay the required amount or fail to abide by other terms and conditions, the lender can sue you and use the lien on your property to recover some, if not all, of the loan money. Talk to your bank to get more information about home equity loans and see whether you could qualify. The interest rate is typically fixed on a home equity loan.

How Does a Home Equity Loan Work?

If your application is approved, the lender disburses the funds through wire transfer or bank check. You can use all the money right away, but you must start the repayment process 30 days after the lender doled out the money. As you repay the loan, the principal balance gradually decreases, but you cannot tap again into the loan portion you already repaid – meaning it does not replenish like a HELOC. What Are Home Equity Loan Requirements?

A home equity lender generally would require the same type of information required under a HELOC application. Requirements vary by lender, so talk to your bank or other financial institution to learn more about the specificities of its home equity loan application process.

Where Can I Get a Home Equity Loan?

You can apply for a home equity loan at any institution, including your bank.

Loan features run the gamut from home equity calculator and online enrollment to online account viewing, home equity advice, lump sum payout, secured site and home equity line of credit.

Can I Refinance My Home Equity Loan or my HELOC?

Yes, similar to other credit products, you can refinance a HELOC or home equity loan if the current terms do not satisfy you and you found another lender offering better terms and conditions.

The Bottom Line

With a HELOC, you get a variable interest rate, but the credit line fluctuates, depending on your payment history. With a home equity loan, the rate is fixed and payments every month. The requirements for both types of loans are similar. You can see here a more detailed "compare and contrast" analysis of a HELOC and a home equity loan.

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